Speculation in early 1970s Britain: A distorted Economy.

Abstract

     

         In 1971 the Bank of England made changes to the banking system that freed the major high-street banks from quantitative controls and restrictions on credit creation. In March 1972, the Conservative Government substituted a free-market economic policy for one that employed loose monetary and easy fiscal policy to encourage investment into industry. Over the following twenty months capital moved heavily into the property market, fuelled by the easier credit conditions, and investment into industry notably dropped. Edward Heath blamed the Bank of England for the distortion in the economy and many in the City criticised the Government for naïve economic management. This paper uniquely examines the property boom and subsequent bust in a wider context. Changes to planning permission, developments in the lease- hold market and new taxation in the earlier two decades also contributed to a volatile property market. In particular, inflation altered expectations for asset prices and engendered fear of holding cash. The end of the boom amid soaring interest rates witnessed a collapse of the secondary banking sector and extraordinary pressure on the primary, main-stream banks. Understanding the period and assignation of blame have to be considered in the context of changes in the property market from the mid- 1950s, policy mistakes made by previous Governments and an embedded British culture of property investment and ownership.

    

Source: Nationwide (property) and Office for National Statistics (retail price index)

     

1.   Background	7
Conservative Party Policy 1970-1972	7
Macroeconomic Background	10
March 1972 Budget	13
2.   The Secondary Banking Sector and  changes in the Money- Markets	15
Competition and Credit Control	16
3.   The Property Market: 1955-1970	18
Property Data	18
Commercial Property	19
Residential Property	23
4.   Property, Inflation and the	25
Political Economy: 1970-1973
Shocks to the Property Market	25
Inflation	27
Inflation and Property	29
The Political Economy	34
Historical examples of Property Speculation	35
and Bank Crises
The Political Economy and the Property Market	35
The End of the Bull Market	36
5.   The Secondary Banking Crisis: 1973 – 1977	39
Solution	42
6.  The Property Market: 1974-1976	45
Commercial Property	45
Residential Property	47
Property unit Trusts	48
7.   Conclusion	49

1

Background

Conservative Party 1970-1972

               The Conservative party under Edward Heath was elected in June 1970. Brendan Sewill, special assistant to the Chancellor of the Exchequer, believed that the Conservatives had a better prepared and more detailed programme than any previous opposition party.[1] Emphasising “disengagement” from state control, the Conservatives promised a free- market philosophy, particularly tax reform, alongside EEC entry and new legislation on industrial relations. Their economic goal was to be achieved by making the nationalised sector more efficient, particularly by stopping subsidies to “lame-duck” firms and abolishing interventionist institutions such as the National Board of Prices and Incomes (NBPI) and the Industrial Reorganisation Corporation (IRC) despite the Bank of England’s approval of the latter.[2]  The Bank believed assistance to modernise industry would raise productivity and the Governor expressed his regret at the winding down of the IRC.[3] Plans to stimulate the supply side of the economy included tax cuts, tax reform and privatisation.

 Source: RPI - Office for National Statistics, Wages - OECD

                       The Cabinet was keen to be decisive but the advantage of preparing early for Government in the late1960s had been offset by the failure to have prioritised price stability.[4] The Conservatives had assumed that fears of bankruptcy would dampen private-sector wage negotiations, but the subdued labour market while in opposition changed to over 11.7% annualised wage inflation in the three years 1969 to 1971, when retail price inflation was only 7% (annualised). Adapting to economic change was further complicated by the death of the Chancellor, Iain Macleod, in July 1970, a man whose intellectual and political stature was considered greater than that of his colleagues.[5]  The new Chancellor, Anthony Barber, had been Economic Secretary to the Treasury in 1962-1963 but the value of his experience was undermined by unfavourable comparisons to Macleod.

            The ambition of the Conservative program was unveiled at the October party conference. Heath promised a “quiet revolution” to reverse the move towards a collectivist economy overwhelmed by state intervention.[6]  This had not been intended as a one-term strategy, but an overall vision of transforming Britain into a modern society. However, Heath had allowed himself to be identified with aggressively free-market beliefs which were not necessarily his own and in some cases alien to him. The philosophy created support from the right wing of the party but alienated the Trade Unions whose assent would become necessary in the future.[7]

            The strategy of disengagement was immediately undermined in November 1970 when the Aviation Minister gave £42 million of state aid to Rolls Royce. By February 1971 the company was insolvent and the Government, fearing wide spread unemployment, nationalised it citing its importance to defence as an exceptional circumstance.[8] Rolls Royce was engaged in building the RB211 engine for the United States’ Lockheed Corporation and possibly foreign policy, along-side unemployment and defence considerations, influenced the rescue. The Government’s credibility weakened further in April and June the following year, when they subsidised the new owners of the Upper Clyde Shipbuilders and then mounted the rescue of Belfast shipbuilders Harland and Wolff.  Heath was conscious that the electorate had blamed the Conservatives for high unemployment in the inter-war period, which they had demonstrated by voting Labour in the1945 landslide, and consequently switched to employment as the main priority.[9]  Following Heath’s U-turn from industrial disengagement, the Economist dryly noted that one of the worst choices for a £35m subsidy was shipbuilding “whose future lies in low wage countries.”[10]

         The Government’s early loss of credibility in industry was matched by its failure to implement a coherent incomes policy. The Industrial Relations Act of 1971 failed to secure wage restraint because of militant action by the Trade Unions, who used the Act as a pretext for expressing political hostility to other policies. The Act had aimed to prevent strikes by codifying collective bargaining to ensure wage agreement, with the National Industrial Relations Court (NIRC) being used in unresolved disputes. However the NIRC often made surprising decisions when adjudicating difficult cases turning relatively minor disputes into matters of unnecessary significance. This often encouraged, rather than prevented, strike action.[11]

           The volte-face was clear with the preparation and enactment of the 1972 Industry Act which allowed Government support for industry, including £5m without parliamentary approval. Shipbuilding, computers, motorcycles and textiles all immediately received Government aid as did the poorer, rural regions. The act even permitted industry to offer share holdings to Government as compensation for grants, prompting Labour’s Tony Benn to acknowledge with ironic humour the new (Conservative) Government’s control over the private sector.[12]

  

Macroeconomic Background

		1970	1971	1972	1973	1974
% annual increase
GDP (real)		2.2	1.6	3.4	5.6	-1.7
Unemployment		2.6	2.8	3.1	2.1	2.2
Wages		11.6	11.7	13.7	17.0	26.4
RPI		6.4	9.4	7.1	9.2	16
M3		8.6	14.0	27.2	27.1	5.7
Trade in Goods		-18	205	-736	-2,573	-5,241
£ millions

    Sources:  GDP, Unemployment, M3:  Economic Trends Supplement (ETAS) 1990,

                    RPI:  Office for National Statistics, Wages, Trade in Goods: OECD.

      

                  

    Source: Bloomberg

                     The Conservatives inherited an economy with a low unemployment rate of 2.6% and positive balance of payments, but by the end of 1971, the Government’s first full year in office, the economy had suffered weaker growth (1.6% compared to 2.2% in 1970) with unemployment soon to rise sharply. In 1972, the current account, which had been positive due to the Labour Government’s monetary squeeze, started deteriorating because of the higher volume of imports following the August 1971 dollar devaluation.[13] The earlier squeeze had been made necessary by a large overhang of Government debt and a negative balance of payments up to and following the 1967 devaluation. In 1972, the unadjusted unemployment figure rose above the politically sensitive 1 million and although the seasonally adjusted figures were more reliable, the number was considered intolerable.[14] With hindsight the fear of rising unemployment was partly misplaced. The Bank of England in early June 1972 noted a positive employment trend and expressed more concern about inflation,  but the political pressure from rising unemployment had broken the Government’s will.[15] When the Chief Constable of Glasgow feared civil disorder during the militant strike action in shipbuilding yards, the rescue of Upper Clyde Shipbuilders had become almost inevitable.[16]

 Fixed investment in manufacturing industry:  £ millions at 1975 prices

1970		4,177
1971		3,898
1972		3,370
1973		3,440
1974		3,782
1975		3,522

  Source:  HMSO, Coopey and Woodward (1996)

          

            Fixed investment into manufacturing dropped by over 6% in 1971 and was forecast to drop further in 1972. The pessimistic view was well founded as the decline in 1972 was eventually over 13 %. Despite cutting purchase tax in 1971, activity in the economy was subdued, reflected by the 5% Bank Rate in January 1972, its lowest since 1964.[17] Heath wanted British Industry to be more competitive before it joined the EEC in January 1973.[18] Cabinet discussion over the winter 1971/1972 focused on further monetary expansion with The Industry Act as a further conduit for policy aimed at promoting growth. On 3 January, Heath invited to dinner several bankers and industrialists including Jacob Rothschild, Jim Slater (who had founded the conglomerate Slater Walker with the Conservative minister Peter Walker) and Nigel Broackes who ran the construction firm Trafalgar House. Nigel Broackes recalled the government “wanted to encourage an investment boom with an abundance of easy credit.”[19]

           The budget was set for 21 March 1972 and although the outcome has been called the “Barber Boom”, the architect was Heath himself. The leader imposed his will on a resigned cabinet and disapproving Treasury.[20] Samuel Brittan acknowledged this in 1977 when he wrote that Barber was the cabinet minister with the least responsibility for the “Barber Boom”.[21] Barber had skilfully implemented Macleod’s tax reforms but was unable to match his predecessor’s political agility in forming policy.

March 1972 Budget

     

Budget Year		Projected Change in Tax		Party
April - April		£  Millions
1960		71		Conservative
1961		58		Conservative
1962		9		Conservative
1963		-594		Conservative
1964		341		Con /  Labour
1965		223		Labour
1966		265		Labour
1967		-12		Labour
1968		923		Labour
1969		340		Labour
1970		-220		Conservative
1971		-671		Conservative
1972		-1809		Conservative

     Source:  The Banker April 1972

           Barber targeted annual growth of 5% for 24 months, and deliberately mentioned the high growth rate because he wanted an “announcement effect.” [22] The target was twice the average rate of the previous decade and was to be achieved by increasing consumer demand with unprecedented tax cuts of over £1,800m (£1,200m through raising personal tax thresholds) and tax relief for loan- interest over £35 per year. Notably industry was awarded tax concessions to increase employment by allowing depreciation on all plant and machinery. William Keegan, writing the lead article for the Financial Times, estimated that Barber’s measures aimed to raise Government assistance to manufacturing investment by £115m in 1973-74 and ultimately by £200m thereafter.[23]  The editorial page called the budget a “Financial Gamble” and quoted Barber: “The high growth of output which I intend to sustain with this budget will entail a growth of money supply that is also high by the standards of past years, in order to ensure that adequate finance is available for the extra output.”[24]

    Source: Bloomberg

         Barber also hinted at the intention to float Sterling, saying it was not “desirable to distort domestic economies to an unacceptable extent in order to maintain unrealistic exchange rates.”[25] The Government was cognisant that an investment boom would possibly lead to a balance of payments crisis, which would undermine the “dash for growth.” It had been less than five years since Sterling’s forced devaluation against the Dollar and cabinet thought that they could pre-empt a payments crisis by floating Sterling and allowing any inflationary fears to be translated into a weaker exchange rate. The Chancellor, emphasising the expansionary policy, concluded his budget by saying that he had never agreed with those who had advocated unemployment as a cure for inflation.

2

The Secondary Banking Sector and Changes in the Money-markets.

          In 1955 local authorities (councils) were required by Treasury to raise money in the open market to supplement Government loans.[26] Cash-rich industrial groups, attracted by the higher deposit rates, competed with hire-purchase firms to lend money to the local authorities. A new inter-bank market was created with secondary banks matching the requirements of borrowers and depositors. The traditional banking sector, “the Clearers”, was still restricted in its lending practices and missed out on this “whole-sale” business. The controls imposed on the clearers were partly due to the numerous sterling crises in the 1960s and they felt unfavourably treated. The other noticeable difference between the clearers and the secondary banks was that deposits in the wholesale market were not guaranteed.[27] The clearers deposited their excess funds with discount houses, which had a preferential position; they were ultimately guaranteed by the Bank of England. The discount houses had the unique facility of being able to discount their assets for cash with the central bank. In other words, the advantage of higher deposit rates in the wholesale market was counterbalanced by the absence of a lender of last resort.

  New money markets (£ millions):

                               Local Authority loans        Inter-bank deposits                   CDs

 

1971                                        1,974                                  2,200                                  2,372

1972                                        2,408                                  4,760                                  4,930

1973                                        3,368                                  7,694                                  5,983

    Source: ECMC Monetary Policy in the Countries EEC, supplement 1974

           The election of a Conservative Government in 1970, keen to encourage competition and free-enterprise, allowed the Bank of England the opportunity to modify the two-tier system of guaranteed and unguaranteed deposits. British Banking had been extremely stable since the Barings crisis in 1890 and consequently the danger of a potential crisis was rarely discussed.[28] The late 1960s monetary squeeze had slowed demand and balanced the external deficit so the timing was propitious to institute expansionary change.

          The Bank had relied too heavily on credit control by quantitatively restricting lending by clearing banks; the secondary banks had had the advantage of being subject to less scrutiny. The Bank was pessimistic about the effectiveness of controls, in particular loan ceilings, and also believed that they were inequitable and undermined relations between the clearers and the Treasury department.[29] The clearing banks had operated a cartel since 1914 which fixed deposit and loan rates at levels closely aligned to the official Bank Rate, a method which contrasted with the whole- sale money market. In the whole-sale market for local authority funds, inter-bank deposits and CDs, deposit and lending rates were determined competitively with less concern for the official Bank Rate. The Bank of England wanted to reassert her monetary influence and narrow the divide.[30]

Competition and Credit Control

          In May 1971 the Bank of England unveiled its consultation document for “Competition and Credit Control” (C+CC). Quantitative controls on lending and interest rate agreements between banks were abandoned. There was to be greater reliance on the market for determining the interest rate and all banks were to place 12.5% of their deposits as “Special Deposits” in the form of Treasury bills, short duration bonds or cash at the Bank of England. The Bank reserved the right to call on the Special Deposits of all the banks and would abandon its previous policy of supporting a weak Gilt market. Lord O’Brien, the Governor of the Bank, emphasised the new ethos: “the allocation of credit is primarily determined by cost.”[31]  The Economist praised the proposal (“Yes, at last, a Revolution for the City”) but concluded that the Bank had essentially admitted to the part played by poor monetary policy in a “disastrous decade for British Economic History.”[32]

                The Treasury was more circumspect in its praise. Abandoning loan ceilings caused them concern, because they viewed such controls as the primary means of squeezing credit. Also, the clearers had used a 28% liquidity ratio (although that included notes and coins), rather than the 12.5%, and it was concluded that interest rates would have to rise to unprecedented levels in the case of a credit boom. In particular, the Treasury feared that Industry would suffer unusually high rates when their traditional lenders, the clearers, were not bound by the agreed cartel rate.[33] In fact Treasury’s prescient assessment of the future Bank Rate in a credit boom was ironically understated because the 5% Bank Rate at the time

was so low, that a move above the politically sensitive 10% rate appeared inconceivable. If the Bank Rate had been higher at the time, C+CC might not have received full Government assent.

       One later change is worthy of note. In September 1972 the Bank Rate was replaced by the Minimum Lending Rate (MLR) which was determined by the Treasury Bill Rate.  This was to reinforce the new thinking; a market determined cost of money that could immediately adapt to prevailing conditions.    

3

The Property Market 1955-1970.

Property Data

          The sources and data for commercial property up to 1971 draws on the work of Peter Scott who aggregated prices from estate agents, trade magazines, newspapers and  the Royal Institutes of Chartered Surveyors (RICS). From 1971 national data from the Investment Property Databank (IPD)  and London data from CB Hillier Parker are used, both widely accepted by the industry. The coverage and transparency of current market indices cannot be matched before 1980 and even indices in the 1980s are based on very small samples. Data from the 1970s cannot be cross - referenced or considered independent. In particular, valuations changed as rent reviews became more frequent which undermined the consistency of prices and indices. This will be discussed further in the next section. The Nationwide Index is used for residential property, which is both comprehensive and consistent, but it should be noted that data were sourced from property purchased with a mortgage which ignored the relatively few debt- free property purchases.

    Source: Scott (1996)

Commercial Property

        Up until 1955 investment into Commercial Property was considered a low risk fixed income investment (bond) because the rent was fixed under long leases from 99 to 999 years. Inflation and institutional demand for an equity type (property) asset changed the market to one where upward only rent reviews were incorporated into leases.[34]  Rent reviews became more frequent falling through steps of 50, 40, 33, 21, 14 and 7 years until the 1970s when 5

years became the standard. Scott (1996) found strong statistical evidence that institutional investment increased with more frequent rent reviews.

    Source: Scott (1996) and IPD

      

      More frequent rent reviews also played a large part in increasing perceived property values in the early 1970s. The British method of valuing property was simplistic; divide the rent by the accepted market yield. Therefore if the rent was £200.000 and accepted yield 5%, the property was valued at £4.000.000. An upward rent review immediately increased its market value. As property itself was the basis of collateral, a rent review would give the landlord more bargaining power when negotiating larger loans.

           The market to invest in commercial property was expanded by the Insurance Companies with (Unauthorised) Property Unit Trusts, which allowed charities and pension funds the ability to invest without having to manage the premises themselves. They were unauthorised for sale to the public but the market was enlarged for the retail sector by the introduction of single premium life policies. These life assurance policies paid bonuses in excess of the life cover commensurate with the performance of a successful property portfolio.  Jonathan Harris was repeatedly advised that the most efficient way for a large surveying practice to start a property company was to create an insurance company or consider a joint venture.[35]

            Development of newly built commercial property in the early 1960s was invigorated by business switching to the use of computers, which required larger floor- space and load-bearing structure than traditional office buildings. [36] A computer required an office with eight meter ceilings, open floor space of 250 square meters and the ability to withstand the considerable weight of a mainframe. Traditional office space was ill- equipped for the technological advance and corporations needed to build property of unusually large dimensions.    

        In November 1964 the Labour Government ostensibly prohibited property development in Greater London. Their intention was to encourage business to relocate out of London in an attempt to decentralise the economy and revitalise towns with older property stock.[37] They were also concerned by traffic congestion in the Capital. The Labour Government required that developers have both planning permission and a special permit from the Board of Trade. They also abolished the practice of awarding compensation of £10 per square foot when a legitimate proposal for planning permission was turned down. 

         Following the supply constriction, The Finance Act 1965 introduced Corporation Tax (40% rising to 45% in 1969) which made direct investment into property more attractive than investment into property companies because the latter resulted in a double taxation for corporate investors. Consequently property companies traded at a discount to their net asset value which often led to hostile takeovers of the weaker, under-capitalised ones.[38]  Developers had their position undermined further in 1967 with the introduction of the Land Commission which bought land for “essential purposes” and imposed a “betterment levy” of 40% when the land was sold or leased. As a consequence of these three factors, the rate of institutional direct investment in property investment rose from an (annualised) average 5.6 % in the period 1948-1964 to 17.8% between 1964 and1973. In a 1971 conference hosted by the Financial Times and Investors Chronicle, it was estimated that between 1966 and 1970 empty office space in the City of London declined from 3 to 0.5 million square feet. Rents had increased by between 200 and 300% due to the tight supply, compounding the inflationary effect, which made property investment appear even more attractive.[39] 

                The intention of the Finance Act which imposed Corporation Tax at the point of distribution of dividends to investors was to encourage manufacturing firms to reinvest profits, but this had an unforeseen consequence for the property sector. Property companies now favoured dealing, which was subject to 30% capital gains tax, over longer-term investment because the latter would create (distributive) rental income that incurred a higher tax liability of 40-45%. Property companies who had surplus rental income were now incentivised to take out more debt and use the surplus to pay tax-deductible interest charges. The optimum strategy was to be highly geared, service debt and retain profits to speculatively buy more property with little intention of investment. The corollary was that the companies that were taken over had many of their assets stripped and sold for immediate profit.[40]

                  In 1970, following the Conservative election, Peter Walker, the Secretary for the Environment, relaxed controls on office development and abolished the Land Commission and its system of betterment levies. This was motivated by attempting to dampen the rental market and it was also the Government’s view that Britain’s entry into the EEC would increase demand for space.[41] The South East planning region had permitted just over 9 ¼ million square feet of development in the 3 years 1966-69, and following Walker’s decision, over 26 ¼ million square feet were developed by the end of 1973.In the 1971 budget,  Corporation Tax was reduced by 5%  which immediately increased corporate retained- earnings. In 1971, the FT Actuaries Property Share Index was the best performing stock-market sector with an annual rise of 61%.[42]

 Residential Property

    Source: Nationwide Residential Index (property-base year 1960)

    OECD (inflation)

               The 1965 Rent Act introduced controls called “fair rents” that were intended to regenerate the private, residential rental market.[43] One estimate in 1968 by Allsop suggested that central London rents were 8-10% below open market value and it was often concluded that the Act galvanised property companies to leave the residential sector.[44] However, the imposition of Corporation Tax also contributed because the tax incentive to deal rather than hold favoured commercial property, because there were more opportunities to trade in large commercial projects than commensurately large blocks of residential flats. Consequently, any large scale transactions in residential property usually involved the break-up of the blocks of flats for immediate sale because holding rent-controlled property had a (corporation) tax cost and implicit loss due to the inability to increase rents. Fear of higher future inflation would make the rent-controlled residential sector even less appealing.

         On the demand side, there was a growing number of entrepreneurs willing to buy residential property because it was sold at a discount to NAV with the secondary banks able to provide credit with minimal central bank regulation. The specialist companies had “trading status” which allowed them to sell property subject to the lower Capital Gains Tax rate. The companies were often partly or even wholly owned by the secondary banks which financed the project.[45] In 1968 the conglomerate Slater Walker bought Drages from Great Universal Stores specifically because Drages owned 50% of a fully authorized bank, Ralli Brothers (Bankers) Ltd.[46]  After acquiring full control of Ralli, the bank was utilised to finance almost all the conglomerate’s projects, notably property.[47] Slater Walker moved into investment services, attracted depositors and created pension funds partly to self- finance take- overs and property acquisitions in the dual role of banker and trader.

        Property had changed from a low-turnover investment market in the early 1960s to an aggressive dealers market when the Conservatives took office. There were 3 distinct groups: Corporate Landlords including pension funds, who were selling the residential part of their portfolios, new trading companies that only dealt and enjoyed lower taxation (30% rather than 45%) and speculative traders who specialized in break-ups. Office space was in short supply particularly in the City and the secondary banks had access to the wholesale money markets to finance property.    

                 

4

 Property, Inflation and the Political Economy: 1970-1973

Shocks to the Property Market

   

       Kiyotaki and Moore (1997) demonstrated that even small temporary shocks to income distribution could generate large fluctuations in asset prices and output.[48] In their model economy, debtors were free from recourse unless their collateral was secured, and credit limits (and their abandonment) interacted strongly with asset prices. The early 1970s property market was financed by secured loans; secured on the property or land itself. To review, there were two income distribution shocks before the Heath Government which had the potential to greatly affect property prices; the introduction of upward only rent reviews (1955-1970) and changes in corporate taxation policy (1965).

        Equally, between 1955 and Heath’s Government there were three other distinct  developments that supported the building and valuation of  commercial property;  a newly-created wholesale interbank money-market (1955-1972), the incorporation of the computer which necessitated  new (larger) office space (1961) and finally the Labour party’s effective ban on development in London and the South East (1964). The reversal of the development ban in 1970 immediately incentivised new investors into a meagrely supplied market. The Economist reflected that the Government had chosen to relax planning procedures because it was a reflationary policy easy to achieve.[49]

            After the election, a sixth policy change, the Introduction of C+CC by the Bank of England (1971), allowed the Clearing Banks to compete with the secondary Banks to allocate credit. This change particularly supported residential property because the clearing banks offered personal mortgages which were no longer subject to quantitative controls. The seventh policy (and income distribution shock) was the volte face by the Conservative Party.

Having cut spending in 1970 and 1971, the dash for growth in 1972 incentivised individuals to borrow more for house purchase because there was now income tax relief on all mortgage-interest.  Equally, fears of unemployment lessened after the 1972 budget. The perceived risk of buying property with a mortgage repaid from earnings diminished as unemployment fell from 3.1% in 1972 to 2.1% at the end of 1973. Monthly Gallup polls asked the question “What do you think is the most serious problem facing the country?”  In 1971 an average of 27% answered “Unemployment” but that figured dropped to fewer than 4% in 1973 and 1974.[50]

    

% increase p.a.                 1970                 1971              1972             1973

 GDP (real)                       2.2                   1.6                 3.4                5.6

 M3                                   8.6                   14.0               27.2              27.1       

  Source: Economic Trends Supplement (1990)

           Two further shocks will be discussed in greater detail. One was the psychological effect of the macroeconomic environment on property buyers, particularly in respect to price-inflation and wage –inflation. The second was the effect of the changing political economy which had prioritised growth and employment without a fully independent central bank to counter inflationary pressures.

          

Inflation

 

    Source: RPI - Office for National Statistics, Wages - OECD

           The quiet employment market of the 1960s was replaced by tougher wage bargaining at the start of the Conservative term. The “Philips curve” relationship, correlating increased unemployment with lower wage increases started breaking down in the early 1970s.[51] Strike activity increased as Trade Union members hardened their resolve to negotiate for higher wages in response to higher inflation. Their attitude was not based on current conditions but expectation because it wasn’t until 1975 that RPI actually exceeded annual wages. In other words, an important source of inflation was the wage-price spiral that created a self- fulfilling upward momentum. In addition to the endogenous wage-price spiral, exogenous events like the breakdown of Bretton Woods and Gold convertibility had precipitated a boom in commodities. Barber floated Sterling in June 1972 and despite its subsequent weakness the balance of payments worsened from a positive £1,123 m in 1971 to negative £1,100 m in 1973 which reflected the overheating economy.

    Source: Office for National Statistics; Economic Trends Annual Supplement 2006

                             The intention of the 1972 budget was to increase investment into manufacturing and create industrial employment; however the Confederation of British Industry’s survey following the budget reported that only 9% of firms planned to increase spending on plant and machinery over the next twelve months.[52] In fact investment fell 13% in 1972 and the 1973 inflation-adjusted level was over 9% less than in 1970. The strong property market had diverted investment away from manufacturing and Heath blamed the Bank of England’s liberalisation of credit controls for the distorted economy.[53]

                           The fall in unemployment to 500,000 after the “dash for growth” was not due to an increase in industrial employment but the creation of 400,000 new public sector jobs between 1971 and 1974, an explicit contradiction of the original ethos of disengagement. Heath’s assignation of blame to the Bank of England and C+CC neglected the part played by Government economic policy, particularly in worsening the inflationary environment. Calomiris (2009) emphasised the point that improving the financial system “depends on the political environment.” [54] Brendan Sewill, Barber’s special assistant, wrote to minsters saying the property boom was “the froth on the top of a pint of beer, undesirable…but perhaps inevitable” but this transpired to be a naive assessment.[55]

 Inflation and Property

  New money markets (£ millions):

                              Local Authority Loans        Inter-bank deposits                CDs

 

1971                                        1,974                                  2,200                                  2,372

1972                                        2,408                                  4,760                                  4,930

1973                                        3,368                                  7,694                                  5,983

Source: ECMC Monetary Policy in the Countries EEC, supplement 1974

       Evidence of inflation’s effect on investment flows into property was linked to credit creation and during 1972-1973 the combination was consistently cited by the larger property investors as the reason to buy property; it was considered the best hedge against higher prices and easy to transact in a credit boom. Mike Slade, CEO of Helical Bar, remembered that the secondary banks tried to lend money at “even more alarmingly competitive levels” and Ronald Lyon, whose Lyon Group collapsed in 1974 with £3m capital supporting £93m loans, recalled the effect inflation had on lenders: “it is no exaggeration to say that we were having bank money thrust at us from all directions.” [56]

         The management of Centre Point on Oxford Street was a more concrete example of the distorting effects of inflation. The skyscraper was deliberately left unoccupied for years by demanding unrealistically high rent. The logic was that a strong trend in rising rents (which reflected inflation) would implicitly revalue the building higher the longer it was left unoccupied. In other words, loss of rent for a given period would be more than made up by increased value and higher expected rent in the future.[57]

         Britain was facing its highest inflation rate since the First World War and there was a lack of confidence in fiat currency. The banks considered property the least risky asset in an inflationary environment.[58] Their view was mirrored by insurance companies and pension funds who needed to invest large cash inflows as inflation increased policy premiums and pension contributions.

           Jim Slater’s expansion into property “was very much stimulated by the availability of easy credit.”[59]  Walker had relaxed development controls when empty office space in London was only 20% of the 1966 level and Slater’s decision to move into banking to finance property created a niche for the conglomerate. He observed that primary merchant banks and clearers rarely took direct stakes in property development.[60] This was symptomatic of the embedded nature of British Banking which eschewed the co-investment between finance and industry favoured by Germany and other continental countries.  Banks and large investors had tended to avoid corporate management preferring liquidity and the ability to sell stock (in a secondary market) rather than deal with the consequences of direct (illiquid) primary investment, particularly during a crisis.[61]  They also feared exposure to a mismatched balance sheet of equity and debt. The banks, unused to direct investment, were forced to increase lending and their focus on the property sector reflected the view that land was sound collateral in an inflationary environment.

    Source: OECD

               The banks’ move into property lending had three direct consequences that would undermine the government’s policy to increase industrial investment. Firstly, it created a paucity of credit for industry that prompted a letter from The Governor of the Bank of England to the banks specifically asking “for further restraint on lending for property development and financial transactions.”[62] The Bank of England was particularly concerned that industry would be unable to increase exports in the face of a deteriorating trade balance. Secondly, short term speculation pushed up property values that dissuaded industry from expansion that required new premises and thirdly, property development increased more quickly than industry’s need for the new supply, distorting the economy with an allocation of unused resources. Veblen (1904) observed that credit for property, which has no industrial use, may be “coined into means of payment” but the property “represents, in the aggregate, only fictitious industrial equipment.”[63] In other words, the speculative property market would not further an increase in British manufacturing productivity favoured by the Bank of England.

        Aside from these reasons, there was a pervasive attitude in Britain that property was an essential part of investment policy. Following the 1972 budget, the editorial of Estate’s Gazette concluded: “Mr Barber’s work can only realise its potential if Mr Walker’s department can be persuaded to adopt a more positive attitude towards the release of land for development.”[64]

            

  The Political Economy and Inflation

	1972		1973		1974
Food	125		179		246
Industrial Materials	113		178		195
Fibres	136		238		216
Metals	98		141		181
All Items	121		178		226

  Source: OECD, Coopey and Woodward          Commodity Price Indices 1971=100

       In November 1972, the Heath Government was forced into another U-turn: incomes policy. The miners had won a 20% wage increase in strict contradiction of the N-1 policy which advocated a wage increase had to be less than the previous settlement. The new directive was implemented in three stages and the 3^rd stage particularly distorted prices by indexing wages to consumer prices, over and above a 7 % hurdle. The indexation was partly based on import prices which rose rapidly during the post -1971 commodity booms and consequently threshold payments were regularly triggered. [65]A combination of the new incomes policy, costly imports due to Sterling weakness and policy aimed at stimulating demand exaggerated asset price inflation because it built up expectations of future price increases. It would become harder to deal with shocks without creating excessive inflation if monetary policy were eased or higher unemployment if either monetary or fiscal policy were tightened. Hartley (1977) described the Heath incomes policy without a concomitant decrease in aggregate demand as an example of “King Canute Economics”; it was simply unequal to the task of restraining militant Trade Unions in an over- heating economy.

       Gallup Opinion Polls, questioning the public on the most serious problem facing the country, also suggested an over-heating economy. In 1971 27 % of the population thought inflation was the most pressing concern but this had risen to 54 % by 1974.[66] 

 

		Advances		Nominal Property
		£ Billions		£ Thousands
Q4 71		£8,526		£5,533
Q1 72		£9,594		£6,008
Q2 72		£12,394		£6,557
Q3 72		£13,486		£7,395
Q4 72		£14,479		£7,880
Q1 73		£16,119		£8,396
Q2 73		£16,804		£8,832
Q3 73		£18,648		£9,183
Q4 73		£20,057		£9,767
Q1 74		£21,130		£9,928
Q2 74		£21,602		£10,027
Q3 74		£22,863		£10,148
Q4 74		£23,082		£10,208
Q1 75		£23,362		£10,388

Source:  BEQB March 1972-June 1975, Nationwide Property Index

                           The rush into residential property during the boom was reflected by the extent of domestic UK bank lending. Between January 1972 and January 1974 advances to UK residents climbed 135% to over £23 billion with a commensurate 76% rise in the Nationwide Housing Index over the same period.[67]

The Political Economy

    Intervention

         In March 1973 upward market pressure on interest rates influenced the Government to intervene in the mortgage market. The building societies required a 10% mortgage rate but the Government felt that its incomes policy was sufficiently punitive to dampen consumer spending. 10% was an emotive headline number which garnered popular criticism as the 1,000,000 unemployment figure had the previous year. The cabinet awarded grants to the building societies to cap the mortgage rate at 9.5%, a policy that was fiercely opposed by Barber, who wanted a much tighter monetary policy.[68] The Bank of England had intended that the quid pro quo for credit expansion in an overheating economy would be higher rates and although the Bank was sympathetic to Barber, did not have the authority to prevent the directive. Lord O’Brien, while expressing admiration for Heath’s integrity, later wrote “He was not easily deflected from what he felt he wanted to do.” [69]

             Cross- country analysis has suggested that excess monetary growth was indicative of a central bank with limited authority and M3 growth in Britain was over 27% in both 1973 and 1974.[70] The Bank had enjoyed considerable freedom, but once Sterling floated its influence on monetary policy waned and Heath’s ministers began to question the Bank’s methods and techniques.[71]  The governor made clear in his annual speech to bankers in late 1972 that monetary policy was too loose and the property market had become speculative: “The state of the property and housing market has become unruly with prices moving wildly ahead; unnecessarily far to provide an incentive for new building.”[72]

          

Historical Examples of Property Speculation and Bank Crises

            

      Calomiris (2009) noted the correlation between property speculation and bank crises. The four countries before World War One with the worst episodes of bank failures, Argentina, Australia, Italy and Norway had two things in common; their Governments had all granted subsidies to real estate risk takers and all four countries had property booms that burst resulting in large losses to the financial system.[73] The Australian boom and bust between 1885 and 1893 was stimulated by Government “land-banks” which lent money on the security of the land. The banks also invested on their own account and the 1864 Victoria Companies Act allowed speculators and banks to exploit accounting loopholes in an unethical manner. Many were associated with fraud at the top of the boom.[74]

         The British speculative boom continued in early 1973, despite rising interest rates, for two reasons. Rather than tightening credit, lenders made the assumption that a liquidation of higher valued property would recoup the interest charges. Their optimism was supported by the questionable valuations assigned by surveyors, particularly at the initial stages of development, and auditors who rarely questioned the (optimistic) estimated completion dates and projected rents. The debt interest often exceeded rental income and unethical accounting made the negative funding more dangerous as entrepreneurs added interest to the cost of their development, when it should have been deducted from profit.[75]  It must be remembered that the secondary banks often had equity stakes in property companies and were reluctant to curtail business. They also had increased operations outside London; office space increased by 25 and 33% in Bristol and Leeds respectively between 1970 and 1975. [76]   

                     The second reason for continued speculation was found in the political economy. Development was widely expected to be constrained by the Government in early 1973. Office space deliberately left unoccupied and low development (capital gains) taxes were creating public disquiet and central bank disapproval. The Government ignored change and even helped the residential sector when they capped the building society mortgage rate. The Economist teased Barber using the imagery of a poodle that did not bite.[77]  London commercial property prices rose by over 25% in the first half of 1973 and in July Heath gave a press conference to financial journalists. Asked whether it was time to restrict credit to help the deteriorating balance of payments, Heath said no.

 The End of the Bull Market

    Source:  BEQB April 1973-June 1974

                                 Three distinct policy changes in response to further deterioration in the balance of payments and excessive Government spending finally halted the property market in late 1973; higher interest rates, fiscal tightening and a re-imposition of bank-lending controls. The money market forced a historically large interest rate rise of 4% in July (MLR 11.5 %) which effectively set property borrowing costs at 14% or higher. The trade gap worsened in November and the MLR was raised to 13%. More ominously the secondary banks now experienced wider credit spreads as the margin they had to pay over the inter-bank rate widened from around 50 basis points to 100-200 basis points as rumours circulated about the solvency of certain secondary banks, in particular London and County.[78] Consequently there were widespread withdrawals of deposits from the money markets which the secondary banks relied on for liquidity and in some cases the banks lost all access to the credit markets and faced collapse.[79] The second policy change, implemented by Barber in an emergency budget (December 1973), increased the top tier of personal tax by 10 % reversing the stated intention of abolition. Finally a “corset” was imposed on banks which penalised them for borrowing in the wholesale market above a prescribed low threshold.        

 

   Source:   Hillier Parker City of London Property Index (base Q3 1972)

         Many developers were caught by the severe rise in interest rates before project completion. Their plan had been to borrow short- term during development and subsequently secure longer- term finance after completion, when tenants took five year (or longer) leases.  However many had underestimated the upward pressure on rates and had chosen to wait before securing the longer term finance.

                 The record MLR and restricted access to credit markets meant that borrowing costs varied from 16-20+%. In December the Bank of England was faced with the insolvency of London and County and Cedar Holdings, the first of the secondary banks requiring help. At the same time the Government’s credibility diminished with the miner’s strike in late 1973-1974 and failure of negotiations to halt industrial action. OPEC 1 had forced oil prices higher following the Yom Kippur war (October 1973) and expensive oil combined with the coal shortage meant industry was forced into working a 3 day week. In early February 1974 Heath

called a snap election asking “Who governs Britain?” and was defeated by Harold Wilson leading the Labour Party.       

5

The Secondary Banking Crisis: 1973 – 1977

        The secondary banking crisis unfolded  between late 1973 and mid 1977 in three distinct stages; lack of liquidity between November 1973 and March 1974, potential insolvency as the property market collapsed into December 1974 and a final phase when the Bank directly intervened and then forcibly took over several institutions . However in early 1973 the Scottish Co-operative Wholesale Society (SCOOP) got into difficulty, a case which exemplified the problems facing the sector  and even as late as 1977  Johnson Matthey and Slater Walker created complications for the Bank and the Labour Chancellor Denis Healey.[80]

       SCOOP had a portfolio of £90 million of Certificates of Deposits (CDs) with commitments to buy £365 million more, which was financed in the inter-bank market at a higher interest rate than the average yield of the CDs. The negative cash flow between low yielding CDs and higher borrowings necessitated financial assistance to avoid insolvency. The Bank of England formed a syndicate with the clearers to support SCOOP but the Bank’s small stake (5 %) created resentment among the other members because of the inevitable losses.[81]    

       

    Source:  BEQB April 1973- September 1974

                        Accurate matching of assets and liabilities was the central requirement to keep secondary banks solvent in a crisis. Clearing banks depended on sufficient cash (and near-cash) assets to meet depositors withdrawing their money and in extremis could rely on the central bank as lender of last resort. The secondary banks accessed the wholesale market for deposits and correspondingly lent large amounts to property companies and other financial institutions rather than holding (lower yielding) Government bonds. Matching assets and liabilities was central to their solvency; that is to say, the aggregate amount of loans and deposits within a given lending period had to be relatively similar. If adequate liquidity was pivotal for the clearing banks, adroit matching was central to the secondary banks.[82]

               In order to create profit, the secondary banks might borrow short term and lend longer term in the more usual situation that the rate of interest increases the longer the duration of the loan.[83] A certain mismatching using a positive yield curve was the accepted way to be profitable. However, in late 1973 when interest rates rose sharply, the secondary banks found they had to borrow at increasingly higher rates and their cash flow turned negative as short term rates often exceeded longer term rates. Figures from the Bank of England’s quarterly bulletin show that at the end of April 1973 40 % of the secondary banks’ borrowings were short term and due to be refinanced within 90 days.[84] The 4% rise in the MLR in July would have greatly harmed cash-flow. The secondary banks with the most mismatched loan books were under the greatest pressure and highly vulnerable to financial contagion because many of their deposits were from other financial institutions. Even premier institutions’ share prices collapsed in a developing situation described by the Governor of the Bank of England as a “contagion of fear.”[85]

Source: Bloomberg               

                        The secondary banks faced two major difficulties from late 1973. Industrial companies were able to continue in the 1973/1974 recession because even if plant and machinery were depreciating in value, they still appeared on the balance sheet at cost less depreciation. In contrast, the assets of the secondary banks included equities and quoted loan stock which had to be valued at the market price; between 1973 and 1974 the Financial Times Stock Exchange Index fell 68%. Furthermore, many of their loans to property companies were made on 33% (land) collateral and consequently in a period when many land values halved, the property companies whom they lent to were already insolvent. This would force the secondary banks to discount their loan books.

        It should be remembered that since C+CC secondary banks had had to compete with established banks that were preferred by the more financially secure counterparts. The secondary sector had riskier, less well matched loan portfolios and large concentrated equity stakes as a consequence of their need to secure business. Lack of banking experience in volatile markets added to their vulnerability.

         

Solution

         The initial solution to the crisis was to ensure immediate adequate liquidity for the secondary banks, whose depositors were not guaranteed by a lender of last resort. The inability of London and County and Cedar Holdings to borrow funds had prompted crisis meetings and The Bank of England coerced the clearers and larger pension funds to contribute to a support fund of £1 billion (“The Lifeboat”) on the evening of 19 December 1973, stating that the meeting would not end until a solution had been found. [86]  The Bank deemed it necessary to have a credible plan before the stock market opened the following day and demanded full cooperation from the clearers. The Economist on 5 January 1974 (“How the City was saved”) made it clear that many “arms had to be twisted in Camelot” even though “the City of London was on the brink of a terrifying collapse”[87] Aware of earlier criticism during the bailout of SCOOP, the Bank contributed 10% to Lifeboat.

                        In May 1974, the crisis entered the second stage with the collapse of William Stern’s £250 million property empire, financed with an unusually high debt to total-assets ratio of 80 %, with interest costs three times the group’s income. The £200 million of bad debt that emanated from Stern made the initial support fund of £1 billion appear inadequate to support the secondary banks, and by July the Lifeboat had already advanced £675 million. Internal correspondence within the Bank of England about a necessary increase to Lifeboat of between £.5 billion and £1 billion contrasted with the anxiety of the clearers who felt that their own depositors, fearing contagion, might withdraw funds as it became clear how dangerous the clearer’s balance sheets had become.[88] The average capital and declared reserves of the clearers was 6 % of total liabilities, less than half the 12.5 % demanded by C+CC. A compromise fund limit of £1.2 billion was agreed and the Bank deemed it necessary for direct intervention into the property market, which was in danger of falling too rapidly.

                      Having enforced cooperation between the clearers and pension funds to add liquidity at the beginning of the crisis, the Bank now persuaded creditors to abstain from demanding whole sale liquidation of property stock when property companies collapsed. For example, under the chair of Sir Kenneth Cork, fifty creditors of Stern agreed not to call in receivers, nor to impose penal interest charges (which they were entitled to) and all promised

property should be slowly sold “off-market” to prevent attention and negative publicity.[89] The “Cork Dam” was supplemented with cooperation by the pension funds and insurance companies who bought large blocks of distressed property to support the market. The larger institutions had retained their faith in property being a good investment during an inflationary period to meet increased liabilities but their commitment to supporting the market was still surprising. There was a necessary collegiate spirit to protect jobs and the City’s reputation, but Plender (1982) suggested the allegiance may have stemmed from the fear of more punitive regulation from a newly elected Labour party.[90]  However, as Veblen (1904) predicted, it certainly constituted a transfer of assets from debtors to creditors.

              The third stage of the crisis, when the Bank made direct bailouts, was made inevitable by the depletion of Lifeboat’s funds and the need for discretion to allay public alarm. Although the Bank would be forced to take over and wind down Slater Walker in late 1977, files in the Bank’s archives clearly demonstrate an early example of secret support. On 31 December 1974 the Bank advanced Slater Walker £10 million of unsecured cash following a meeting 10 days earlier between Slater and the    Governor, Gordon Richardson. In response to a letter on the 6 February 1975 by the financial director of Slater Walker, asking for written confirmation of the loan, D. Somerset, deputy chief cashier to the Bank of England, replied “I should perhaps explain that the advance of £10 million…was treated here as strictly confidential and, as a consequence, the staff dealing with your request were not aware that it had been made.”[91] The Bank’s concern with Slater Walker increased during 1975 and after Slater’s resignation and a full audit by accountants Peat Marwick and Mitchell and Price Waterhouse, the extent and complexities of the conglomerate’s borrowings necessitated a Bank of England bail out of £40 million to protect the group’s depositors. When Richardson briefed the new Chancellor, Denis Healey, it was agreed that knowledge of the bailout should be kept “to a select few”.[92]

Three Largest Secondary Banks by Gross Assets
	1971	1971	1973	1975	Peak-
					trough %
	Gross Assets	Pre-tax	Pre-tax	Pre-tax	share price
£ millions		profit	profit	profit	change
Slater Walker  Securities	280	16	23	-40	-89
FNFC*	182	8	18	-83	-92
United Dominions Trust	466	11	24	-54	-98
*First National Finance Corporation

     Source:  Reid (1982)

           Eight of the twenty six companies that received Lifeboat support eventually went into liquidation, eleven were taken over but four banks did manage to regain profitability and survive. Richardson was widely praised for Lifeboat and the handling of the crisis, particularly as the necessary cooperation between clearers, pension funds and insurance companies had been achieved by his ability to negotiate terms that were not in everyone’s interest. [93] By organising the private, off-market sale of property stock from specialist companies to pension funds and insurance companies, an avalanche of sales and adverse publicity were avoided. The transaction prices were artificially high but the wider interests of the financial system had been satisfied. The solvency levels of the insurance companies had fallen to 25% in 1974 (the accepted minimum level was 40%) and because property was being transacted at support- price levels, institutions were able to mark the rest of their property portfolio at commensurately higher valuations.[94] Richardson had possibly used this as a bargaining tool to allay the insurance companies’ fears of even lower and more dangerous solvency levels.

6

The Property Market 1974-1976

Commercial Property

 

    Source:  Hillier Parker London Property index  

     

       The rise in the value of collateral (land) influenced the expansion of credit during the boom, but when land prices fell and loans had to be written down, credit quickly diminished and the property companies found themselves isolated. The bailout of London and County and Cedar Holdings was a tipping point that marked large, sometimes enforced, liquidation of property. Lifeboat only advanced capital to the secondary banks, not to property companies themselves. Pension funds had mistakenly entered the market with the attitude that buildings decayed, but land did not and upward only (ground) rent reviews would lend support to land prices. If the Pension funds and Insurance Companies had not kept participating in the 1974 / 75 bear market (with Bank of England encouragement)  the self-fulfilling cycle down of lower land values leading to even less credit might have been more dangerous. It should therefore be seen that the crash was a banking and property company crisis rather than a crisis in land investment with pension funds and insurance companies buying distressed property from property companies and secondary banks.

Net Investment in Property (£ million)

                                                     1970            1974           1975            1976           1977

Insurance Cos and                         294              710             748              962             944

Pension Funds

Capital Market and                        47                (2)              106              90               54

Property Unit Trusts  

Banks                                             16               979              98               (58)          (166)

Total                                               357            1.687          1.052            994            832

    Source:   Financial Statistics HMSO.

               

                 By March 1974 property auctions were being cancelled and the few property deals being transacted were done privately at large discounts to 1973 valuations. Deposit rates of over 15% were too attractive in comparison to investing in property and the newly elected Labour Party was not considered sympathetic to the sector. Michael Peachey of Hammerson, the builder of Brent Cross, Europe’s largest shopping Centre, recalled “we didn’t panic at Hammerson, but we certainly had to start selling.” In August 1974 the environment darkened. The Bank of England demanded more disclosure from the secondary banks and commercial Estate Agents Jones, Lang and LaSalle held a crisis director’s conference and the minutes state “there remains very little evidence of completed transactions at any level.” [95] Property companies rapidly contracted in size and even after the late 1970s recovery, their assets of £7 billion in 1980 were a third less than in 1970 despite a decennial inflation rate of over 13% compounded.[96]

              During 1974 financial companies struggled as the stock market fell to its nadir in December when the Bank of England had to quash rumours that National Westminster Bank was insolvent. The declining stock market added pressure to the assets of the secondary banks, restricting their ability to lend and at the same time the clearers had most of their reserves placed in Lifeboat. By the end of 1974 Lifeboat had only £18 million with the Bank

facing the likelihood of requiring its reserves to support the failing secondary sector. After a 1.7% fall in GDP in 1974 neither the clearers nor secondary banks had sufficient capital to consider industrial investment, however five large insurance companies collaborated and bought the oversold stock market in early 1975. This was widely believed to be with Bank of England encouragement and it helped many vulnerable balance sheets as the market rose dramatically 50% in January alone.[97]  

Residential Property

      

    Source: Nationwide and OECD

                               The newly elected Labour party in February 1974 lost control of incomes policy and the miners’ victory heralded unparalleled wage inflation of over 26% in 1974. The Residential sector rose 15% (nominally) in 1974-75 but fell over 25% in real terms. The market mechanism for unwinding excess speculation came from higher wages (26.4%, 16.8%) which returned UK average house prices to the longer term average of 2.8 times average-income. Individuals tended to have only one property and did not have the complex, over-leveraged balance sheets of the secondary banks and property companies. The clearers and building societies rarely lent more than three times income and consequently even late buyers in the boom remained solvent as higher wages allowed overstretched borrowers to maintain interest payments. If the Labour party had managed a tight fiscal policy in the mid-1970s, with the same success as they had following the 1967 devaluation, and controlled wage inflation, the residential market (and clearers) may well have been under considerable pressure. This counterfactual would be an interesting topic for further research.

      

Property Unit Trusts

          Property unit trusts were the other long-term losers in the crisis with the secondary banks and property companies. In 1973 property unit trusts accounted for 8.6% of all institutional investment into property but fell to 5.1% by 1980 due to forced selling when redemption requests increased. Furthermore, during the bear market surveyors had been slow to lower valuations, because they required evidence of comparable transaction prices, and consequently unit trust valuations were often too high.[98]  This had enticed unit holders to immediately sell their holdings and in a low-volume, falling market only the best property could be sold with the remainder lowering the quality of a portfolio. In many cases investors who remained had had to accept unusually large losses by in effect compensating the early sellers. The combination of mispricing and ability to exit easily was an unforeseen consequence because previously high transactions costs in property trading had thwarted short term selling. When the property market did recover later in the decade, investors were more circumspect when considering unit trusts.

7

Conclusion

    

            The property boom and bust in the early 1970s cannot be blamed on the Conservative Government and Bank of England alone. Institutional demand for commercial property had been incentivised by upward-only rent reviews, particularly in an inflationary environment. Earlier changes in policy had created the foundation for upward shocks to property prices: severe development restrictions in the South East, anomalies from changes in taxation and the creation of a whole-sale money market open to the secondary banking sector. In effect an extraordinary confluence of specific property shocks and macroeconomic events culminated in the speculative bubble following the 1972 budget. The Bank of England was complacent about C+CC due to a long, uninterrupted period of safe banking but at least recognised early an overheating economy. Lack of independence prevented the Bank asserting authority but considerable kudos was regained by adept handling of the secondary banking crisis.

               Britain was not the only country that experienced an investment boom in 1972/1973. The world economy had grown quickly, and other countries’ policy makers had underestimated the inflationary environment following the breakdown of Bretton Woods. However there were two strategies that reflect badly on the Conservative Government and Heath in particular. Firstly, the Government naively concluded that capital formation from cutting taxes, protecting wages from price increases and consenting to easier credit would primarily benefit industry. Secondly, the volte-face in economic policy; the Government had prepared for four years a policy of disengagement only to reverse course when public opinion changed. Heath had chosen to reject party policy to manage the economy and prioritise growth and employment with little concern for inflation and the balance of payments. This was particularly lamentable as many sources suggest Heath often ignored prescient advice from the Bank of England, Treasury and his own Cabinet.

              

Bibliography

Primary Sources

Bank of England Archive: File 6A 70/3

Harris, J. Inter alia: Senior Partner (1974-1994): Pepper Angliss and Yarwood, Chartered Surveyors 1959-1994,  Advisory Property Group of Bank of England 1999-2000, President of Royal Institute of Chartered Surveyors 2000-2001

Research Papers.

Calomiris, C. 2009 Banking Crises and the Rules of the Game (NBER Working Paper 15403)

Kiyotaki, N and Moore, J., 1997, Credit Cycles (The Journal of Political Economy, Vol.105)

Royal Institute of Chartered Surveyors 1999, The UK Property Cycle-a History from 1921-1997 (RICS, 1999)

Scott, P., and Judge, G., 2000, Cycles and Steps in British Commercial Property Values. (Applied Economics, 2000, 32 1287-1297)

Simon, J., 2003 Three Australian Asset Price Bubbles. (Reserve Bank of Australia Publications)

Books

Blackaby, F., 1978 British Economic Policy (Cambridge University Press)

Brittan, S., 1997, The Economic Consequences of Democracy (Temple Smith)

Broackes, N., 1979, A Growing Concern (Littlehampton Book Services)

Capie, F., 2010, The Bank of England: 1950s-1979 (Cambridge University Press)

Campbell, J., 1993, Edward Heath: A Biography (Jonathan Cape, Random House)

Coopey, R., and Woodward, N, 1996, Britain in the 1970s: The Troubled Economy (UCL Press)

Crafts, N., and Woodward, N, (eds.) 1991, The British Economy since 1945 (Clarendon Press, Oxford)

Harris, R., and Sewill, B., 1975, British Economic Policy 1970-1974; Two Views (The Institute of Economic Affairs)

Hartley, K., 1977, Problems of Economic Efficiency (Allen and Unwin)

Hamnett, C., and Randolf, B., 1988, Cities Housing and Profits (Hutchinson)

Healey, D., 1989, The Time of my Life (Michael Joseph)

Holmes, M., 1997, The Failure of the Heath Government (Macmillan Press)

Homes, M., 1982, Political Pressure and Economic Policy: British Government 1970-1974 (Butterworth Scientific)

Marriott, O., 1989,The Property Boom (Abingdon Publishing)

Plender, J., 1982, That’s the way the Money Goes (Andre Deutsche)

Raw, C., 1977, Slater Walker: An investigation of a Financial Phenomenon (Coronet Books)

Reid, M., 1982, The Secondary Banking Crisis, 1973-75 (Macmillan Press)

Scott, P., 1996, The Property Masters: A History of the British Commercial Property

Sector (Taylor and Francis)

Slater, J., 1997 Return to Go  (Weidenfield and Nicholson)

Veblen, T., 1904 The Theory of Business Enterprise (The New American Library)

Publications.

Bank of England Quarterly Bulletin:

June, September and December 1971  

March, June, September and December 1972                                                      

March, June, September and December 1973

March, June, September and December 1974

March 1975

The Banker:

April 1972                                                                 

The Economist:

November 7 1964

 April 4   1972

 May 13   1972

 May 22   1972

 January 27   1973

 January 5    1974

Estates Gazette:    April 1 1972

Investors Chronicle: April 7 1972

Financial Times:   March 22 1972

Opinion of the Lords of Appeal for Judgment; Regina v. Secretary of State 7 xii 2000

Property Week:     September 21 2007. Penfold, D., A History of Modern Property: part one 1971-1979 (Ref no. L140533 RICS)

Property Week:   September 25 2009. Hipwell, D., Return to the 1970s to predict 2010 revival

Times:       August 21   1974

---

[1] Harris, R. and Sewill, B. (1975)  British Economic Policy 1970-1974; Two views  p.31

[2] Kirby, M. (1991) in Crafts, N., and Woodward, N; The British Economy since 1945  p.251

[3] Capie, F (2010)  The Bank of England 1950s to 1979  p. 324

[4] Harris and Sewill, Op. cit.,  p.31

[5] Holmes, M (1997) The Failure of the Heath Government  p.9

[6]  Ibid.,  p.11

[7]  Campbell, J (1993) Edward Heath: A Biography  p.266

[8]  Holmes Op. cit., p.40,  Kirby Op. cit.,  p.250

[9]  Coopey, R. and Woodward, N (1996)  Britain in the 1970s: The Troubled Economy  p. 121

[10]  The Economist 4 April 1972

[11]  Coopey and Woodward  Op. cit.,  p.40

[12]  Ibid., p.39  the Act “provided the most comprehensive armoury of Government control that has ever been assembled for use over private industry”

[13]  Nixon closed the Gold window and the dollar fell sharply against all major currencies.

[14]  Holmes,  Op. cit.,  p.46

[15]  Bank of England Quarterly Bulletin (BEQB) 2 June 1972  p. 179   pp. 226-238

[16]  Holmes,  Op. cit., p.44

[17]  Capie,  Op. cit.,  p.512

[18]  Reid, M. (1982)  The Secondary Banking Crisis, 1973-1975  p.70

[19]  Broackes, N. (1979)  A Growing Concern p.221

[20]  Campbell  (1993) op. cit., p.523

[21]  Brittan, S  (1977) The Economic Consequences of Democracy p.9

[22]  Blackaby, F  (1978) British Economic Policy 1960-1974  p.64

[23]  The Financial Times 22 March 1972  p.1

[24]  Ibid p.8

[25]  Ibid p.9

[26]  Reid,  Op. cit.,  p.24

[27]  Ibid  p.25

[28]  Capie,  Op. cit. p. 484,  p.524

[29]  Ibid p. 427

[30]  Dimsdale,  Op. cit.,  p.118

[31]  BEQB June 1971 p.196

[32]  The Economist  22 May 1972  p.75

[33]  Capie,  Op. cit., p.506

[34]  Scott, P and Judge, G (2000)  Cycles and Steps in British Commercial Property Values

[35] Interview with Jonathan Harris: President of the Royal Institute of Chartered Surveyors 2000/2001 (see bibliography for  brief résumé)

[36]  Harris. Op. cit.

[37]  The Economist 7 November 1964. “Full Stop for London Offices”

[38]  Scott, P (1996) The Property Masters: A History of the British Commercial Property Sector. p.167

[39]  Estates Gazette 1 April 1972  p.93

[40]  Hamnett, C and Randolf, B (1988) Cities Housing and Profits  pp. 107-109, 126

[41]  Scott,  Op. cit., p.184

[42]  Investors Chronicle April 7 1972.

[43]  Opinion of the Lords of Appeal for Judgment; Regina v. Secretary of State 7 December 2000.

[44]  Hamnett and Randolf, Op .cit.,  p. 103

[45]  Hamnett and Randolph, Op. cit.,  p.113

[46]  Slater, J (1977)  Return to Go p.100

[47]  Capie, Op. cit.,  p.559

[48]  Kiyotaki, N and Moore, J (1997)  Credit Cycles

[49]  The Economist 27 January 1973 p. 56 What Price Land for Housing?

[50]  Coopey and Woodward, Op. cit.,  p.1

[51]  Ibid.,  p.110

[52]  BEQB  June 1972  p.163

[53]  Campbell, Op. cit.,  p527

[54]  Calomiris, C (2009)  Banking Crises and the Rules of the Game.

[55] Campbell, Op. cit., p.531

[56]  Property Week 21 September 2007 p.38;   Quote from Mike Slade, CEO of Helical Bar.

    The Times 30 November 2004. Obituary of Ronald Lyon.

[57]  Scott, Op. cit.,  p. 195

[58]  Plender, J (1982) That’s the way the money goes  p.97

[59]  Slater,  Op. cit.,  p 152

[60]  Ibid,  p 120

[61]  The Banker April 1972  p.433

[62]  BEQB  December 1973 p.445

[63]  Veblen, T (1904) The Theory of Business Enterprise p.54

[64]  Estates Gazette  1 April 1972

[65]  Crafts and Woodward,  Op. cit., p.251

[66]  Coopey and Woodward, Op. cit.,  p.1

[67]  BEQB table, 8 March 1972, March 1974.  Nationwide Housing index: End 1973, 1971 average prices.

[68]  Reid, Op. cit.,  p. 75

[69]  Ibid p.76

[70]  For example see Coopey and Woodward p.251

[71]  Capie, Op. cit.,   pp. 773-775.

[72]  BEQB December 1972 p 517

[73]  Calomiris, C (2009)  Banking  Crises and the Rules of the Game.

[74]  Simon, J (2003 Three Australian Asset-price Bubbles.

[75]  Plender, Op.cit.,  pp. 96-97

[76]  Scott, Op.cit.,  p.186

[77] The Economist: 10 March 1973

[78]  Capie, Op. cit., p. 534. On 30 November 30 share- trading was suspended in London and County.

[79]  Reid, Op. cit.,  p. 82 and Capie, Op. cit.,  p. 534

[80] Healey, D (1989) The Time of my Life p. 374

[81]  Capie, Op. cit., p. 530. It is also worth noting that rising interest rates in 1973 would create even more expensive borrowings for SCOOP when it was time to honour their commitment to buy the extra CDs.

[82]  Reid, Op. cit., p. 27.  It is interesting to note that Reid had concluded that “matching” was relatively little understood even at the time of publication (1982). This was confirmed in the April 2011 interview with Harris.

[83]  This is called a positive yield curve. A negative yield curve is where short term rates are higher than longer term rates

[84]  BEQB September 1973  p.309

[85]  Capie, Op. cit.,  p.538

[86]  Ibid, p. 537 Chapter 1 of Reid (1982) further describes the meeting.

[87]  The Economist 5 January 1974.

[88]  Capie, Op. cit.,  pp. 548-9

[89]  Sir Kenneth Cork was senior partner of W.J. Cork Gulley the largest insolvency practice in Britain.

[90]  Interview: Jonathan Harris

[91]  Bank of  England File 6A.70/3 on Slater Walker.

[92]  Capie, Op. cit.,   p. 562

[93]  Capie, Op.cit.,p.586,  Reid, Op. cit., p. 193, Slater, Op. cit., p. 199,  Healey, Op. cit., p.375  and interview with Harris.

[94]  Scott, Op. cit.,p.198.  A Solvency level is the excess of assets over liabilities.

[95]  The Times 21 August 1974 p.15  and Property Week 25 September 2009 p.22

[96]  Plender, Op. cit., p. 89   Note that 13.6% compounded over the 1970s represented a 258% increase in   prices.

[97]  Capie, Op. cit., p. 551 and  Slater,  Op. cit., p. 206

[98]  Interview: Jonathan Harris.